Tag: recession

Market Commentary 3/31/2023

Posted on by Damon Germanides

Slowing Inflation Encourages Market 

While the recent banking crisis appears to be receding, there are still issues to be dealt with. Our belief is this will not become a 2008-type event, but the failure of SVB and Signature Bank has shown how fragile our banking system is as well as how quickly panic can set in. It only took two days for SVB deposit withdrawals to crater the bank. The long-term ramifications of these two bank failures will be felt in the form of more bank regulation and tighter lending standards. 

This Friday’s Core PCE reading, the Fed’s favorite inflation gauge, came in at 0.3% or 3.6% annualized. While this is still far too high, it is encouraging. However, the Fed remains resolute in its battle against inflation. They maintain their higher-for-longer stance on short-term interest rates. Their intention is to continue raising rates while the economy is still growing, and unemployment is low, as they fight inflation. We are not sure if this is the right decision, but history has shown that inflation is difficult to break once it is entrenched in the overall economy. This leads us to think that the Fed will keep short-term interest rates elevated for longer than many on Wall Street anticipate. Should these rates continue to rise beyond Wall Street’s expectations, volatility in the bond and equity markets will likely revive later in the year. 

Most of the news on loan defaults and property impairments is centered around office properties. Single-family residential loans are on solid footing. While valuations on single-family homes have fallen, they have not fallen dramatically. Many homeowners have locked in low long-term mortgage rates, potentially mitigating the need to sell.  This will act as a floor to price declines. Spring activity in housing is encouraging. We believe the worst is behind us, as clients adjust to the higher rate environment. 

Market Commentary 3/17/2023

Posted on by Damon Germanides

Thoughts On Bank Runs, Dropping Rates, And Then Some.

This past week has been quite turbulent for us all. We witnessed two major bank failures with Silicon Valley Bank and Signature Bank, along with several large regional banks, such as First Republic, suffering a massive loss of market value. Internationally, Credit Suisse faced challenges due to fears of contagion spreading to systemically important banks.

Concerns persisted throughout the week despite numerous efforts. These included government guarantees for the depositors of SVB and Signature Bank, an additional big facility to backstop US banks, the injection of $30 billion deposits by a group of large US banks into First Republic, and finally, the National Bank of Switzerland stepping in for Credit Suisse. This crisis of confidence stems from years of a zero-rate lending environment that encouraged banks to purchase longer-dated bonds and Treasuries, as well as to hold longer-dated mortgages and bank-originated loans on their balance sheets in pursuit of higher yields. As the Fed increased rates significantly, the value of these loans decreased, resulting in potential “run on the bank” risks.

It’s crucial to note that the current mark-to-market issue is different from the 2008 crisis. In 2008, the issue was with poorly underwritten mortgages that became worthless when real estate prices stopped rising. Today, banks hold more capital in reserves, which can help cushion the blow to their balance sheets. Although the situation is stressful, it’s likely that the Fed and Treasury will find a way to calm the markets in the coming days. However, there is always the tail risk of an unknown factor creating a more significant problem.

This banking debacle has implications for everyone in the real estate business, including realtors, mortgage bankers and brokers, escrow, and title companies. The decrease in confidence will likely hurt spending, delay house-hunting, and put additional pressure on sellers to lower prices. The drop in interest rates, now below the mid-5% range for most lending products, might provide some relief as banks tighten lending standards. Nonetheless, confidence has been hit hard. We suspect potential buyers to enter the market very cautiously for some time, even after equity and bond markets settle down.

The shrinking yield curve inversion has increased the probability of a recession. Historically, the unwinding of the inversion signals a higher probability of recession. The decisions of the Federal Reserve and European Central Bank regarding interest rates will further impact the global marketplace. How these institutions will balance market stabilization and inflation control remains to be seen.

Mortgage Brokers In The Current Market

Seasoned mortgage brokers are poised to play an essential role amidst the shift in the financial landscape last week. Numerous lesser-known lenders offer competitive rates, common-sense underwriting, and reasonable depository requests (at FDIC limits) as part of their portfolio product offerings. From complex full-doc loans to loans with as little as 5% down up to $1.5 million, and even stated income loans, these products are provided by regulated institutions. They are often priced better than those offered by large mortgage bankers. At Insignia Mortgage, we have experienced a significant uptick in loan requests, as borrowers seek these products without needing to transfer a substantial portion of their personal or business assets.

Market Commentary 3/10/2023

Posted on by Damon Germanides

Treasury Yields Drop As Regional Banks Show Signs of Stress

Treasury yields dropped precipitously on Friday, but for all the wrong reasons. Several California-based regional banks experienced a sharp drop in equity values as customers withdrew money out of fear the banks may become insolvent.  Silicon Valley Bank (SV) was seized as it was forced to liquidate its bond portfolio due to a negative interest rate margin. In basic terms, this means the bank was paying more to depositors than to borrowers. Fear bled over to the First Republic and the Signature Bank as those stocks were down heavily. These episodes are the result of a decades-long easy money cycle that forced banks to buy long-dated bonds as well as lend money at near-zero interest rates. Additional uneasiness surrounds the fact that there’s never just one cockroach in the room – that these banks, unlike the banks of the 2008 Financial Crisis, are heavily regulated. As a result, they were supposed to have ample capital in reserves to protect against stressful scenarios. In the case of SVB, it still failed. Of further concern is the fact that SVB has been the bank to the most coveted part of the economy for the last 10 years. Their technology and their management team were presumed to be world-class. Yesterday I was telling a friend that the last two days were reminiscent of the Bear Sterns collapse. History does not repeat yet it often rhymes.  However, to keep this all in perspective, the big money center banks, or more bluntly, the banks that really matter from a systemic standpoint, maintain abundant capital reserves. So, while the SVB collapse is worrisome, I do not believe we are reliving 2008 all over again.

The Jobs Report came in a bit above expectation and wages grew slower. This takes the .50 basis point hike off the table (especially after today’s negative events in the banking sector). The Fed will most likely go .25 basis point at its next two to three meetings as inflation remains a problem but could change quickly. We assume the Fed funds rate to top off at 5.75% to 6.00% before turning the other way. There is a sense of apprehension in the air now and I think consumers, risk-takers, and business owners will continue to hunker down. Perhaps, the Fed’s work of raising rates to slow the economy and encourage a more cautious spending public is now at play.   Higher interest rates have already slowed real estate activity by making mortgages unattractive. They’ve also lowered commercial real estate values and are hitting equities now in a meaningful way. The pain of a slowing economy is beginning to take hold. 

What are we to do?  Business, real estate, and life have cycles.  Real estate is in an adjustment phase and prices (as we have reiterated) will need to adjust to the new era of higher interest rates. Anecdotally, many brokers I speak to realize that price reductions will lead to buyers returning to the table.  While not great news for sellers, this is the reality of a free marketplace.  The good news is the Fed is nearer to the end of the rate hike cycle than the beginning. Once there is consensus on a rate ceiling, the uncertainty of higher interest rates will dissipate, and activity will resume.  However, waiting for that time will not be without some additional distress, I am afraid.

Market Commentary 2.24.2023

Posted on by Damon Germanides

Markets Rethink Inflation Amidst Fed Pivot

The quote “this too shall pass” may be apropos for the strain of higher inflation, higher interest rates, and increased volatility is having on all of us. For the mortgage market, it is an arm-wrestling match with interest rates, each day, in real-time. 

Unfortunately, our instinct has been that once inflation is left to run hot for longer, it infects all aspects of the economy and does not retreat quickly.  We opined recently that we were concerned Fed Chairman Powell’s press conference in early February was way too optimistic about the pace of cooling inflation. Also odd was the Fed’s belief that financial conditions were nearing a neutral level of tightening while most economists were seeing financial conditions ease up again.  All of this has now come home to roost with CPI, PPI, January jobs report, and PCE, all of which came in hotter than expected. It is now widely believed that the Fed will need to raise interest rates further while also holding rates higher for longer to ensure inflation is wrung out of the system.

Financial Reality: Recession, Rates, & The Grind

Regardless of the popular belief that rates will continue to rise for a longer period, we suspect that the economy may be in a recession. As a result, the higher cost of living is impacting spending, which may come through in the data sooner than later. Mortgage rates are certainly making it harder for borrowers to qualify for home loans as well as purchase or refinance commercial properties. Bank liquidity remains tight, credit card balances are soaring, and high-risk auto loans are rolling over. All are signs that the consumer is under pressure. The lagging effects of monetary policy take time and the thinking is that the jumbo rate hikes from last year take about 9 months to work their way into the system. Should the economy fall into an official recession, the Fed will be forced to lower rates. At what point the Fed rate hikes break something is unknown, but we are no longer in a low-interest rate market as interest has returned to a normal level. 

Our motto is that you must live in the world you are in, and not the one you want. Applying this to real estate means working much harder for much less, and seeing deals come and go. Again, we are of the firm belief that many prospective buyers are actively looking for a discount on the price to overcome the big increase in monthly mortgage payments. We are starting to see signs of more favorable negotiations between buyers and sellers, which is encouraging. For the deals that big banks refuse to fund, local banks are doing whatever they can to make common sense decisions on successfully closing such deals. The reinstatement of a busy market will take time. For now, it remains a grind. 

Market Commentary 12/16/2022

Posted on by Damon Germanides

Recession Fears Escalate As Fed Holds Firm On Rate Hikes 

As anticipated, The Fed raised short-term interest rates by .50 bp on Wednesday. The initial market reaction was neutral, but sentiments changed once the markets digested the Fed’s resolve to fight inflation on Thursday. Additionally, the Fed emphasized its projection that short-term interest rates may go higher than expected due to the very tight labor market. The markets are concerned because the economy seems to be weakening. Major corporations have announced job cuts, credit card balances have risen, and U.S. retail and manufacturing spending has slowed. Market experts are attempting to reconcile how far the Fed is willing to see real estate and equity markets decline, rather than not do enough to squash inflation. The most vulnerable parts of society are hurt by inflation the most. Powell has referenced the need for “pain”(financial pain or the decline in asset prices) several times over the last many months as the unfortunate result of taming inflation.

Across the pond, European central bankers were also very hawkish about where interest rates will need to go to quell inflation. U.S. Treasury yields remain very volatile as expectations of tighter financial conditions loom. Speaking of bonds, the inverted yield curve is an excellent indicator of recession probability. How steeply the yield curve dips signifies to the bond market that a recession is likely.  However, a counterargument can be made for higher interest rates as liquidity is taken out of the system.  It seems logical investors will demand more yield for each unit of risk. Interest rates along the yield curve should move up. Also, onshoring of industrial production and pivoting from just-in-time inventory to certainty-of-inventory, employee demands for higher wages, as well as a low level of “total employed” are inflationary. In the end, the best financial advice this year has been to “not fight the Fed.”  The Fed wants positive real rates across the whole yield curve and fighting the Fed is usually not wise.  While no one can predict the future, we are in the midst of a paradigm shift in interest rates. The results of this shift will be felt in the coming year.

Interest rates have dipped slightly, and that has led to a small increase in activity. Winter has always been a historically slow time of year, but the jumbo hikes the Fed has undertaken have certainly slowed the market. With inflation coming down, the hope is interest rates will normalize and thereby help the real estate market. As 2023 approaches, lenders will have new funding targets, which should help as banks compete for new business. 

Market Commentary 11/18/2022

Posted on by Damon Germanides

Mortgage Rates Continue To Fall In Uncertain World

Over the past several decades, the inverted yield curve has been a tried-and-true recession predictor. With some parts of the year yield at historically wide inversions, financial conditions are becoming too tight. This indicates a strong likelihood that the economy is slowly marching toward a recession. However, there is evidence to the flip side of this argument, including consistently strong employment data, decent capital spending by companies, and a rebounding stock market.

Housing has been hit pretty hard by the 4 super-sized rate hikes by the Fed, with more upset on the horizon with the additional hikes anticipated in December and early next year. The terminal rate should cross 5.00%. Some Fed officials have opined the need to go much higher to stomp out inflation.  A recent Fed study on housing speaks of the potential for a 20% adjustment to prices in specific markets.  Speaking to our market, prices will continue to come down, but the lack of inventory will set a floor for how low prices can go. As long as California continues to be a robust and diversified economy, wealth creation, weather, and opportunity will support prices better than some other parts of the country. Nevertheless, affordable housing remains a big problem on a national level, and the Fed will want to see housing prices fall. Such a decline won’t be as severe in the more undersupplied and desirable areas.

Important Update On Mortgage Products

Insignia Mortgage has located a few portfolio lenders willing to offer very sharp pencils on non-traditional loan products. These non-QM products rely on post-closing reserves more than income analysis.  Loan amounts go up to several million with a 30% down payment. Interest rates begin at 5.00% or so. We share this info because these types of products are crucial for the high-end markets, especially with the move in interest rates. Borrowers are struggling to qualify for loans due to the rapid rise in rates, and the fact that interest-only loans require an additional stress test, making it difficult for well-qualified borrowers to obtain financing. 

Market Commentary 10/7/2022

Posted on by Damon Germanides

More Pain On The Horizon As Fed Pivot Is Deferred

The decent September jobs report had a “good news is bad news” effect on the markets. Traders were looking for signs that the Fed’s super-sized rate hikes are lowering wage inflation, which would indicate that overall inflation may be coming down. While wage growth eased and the overall jobs picture declined, it was not enough to sway the Fed from its restrictive stance. More likely than not, another .75 bp rate increase will occur at the next Fed meeting. Combining these large rate hikes with the balance sheet runoff, also known as QT, is quickly creating very cramped financial conditions. Our suspicion is that it will not take much longer for the Fed to break something in the financial system. Risks are high for a black swan type of event. There is real destruction happening in the marketplace as riskier bond yields start to tick up again. Oil is now over 90 and investor confidence is crumbling. It seems unlikely that the Fed can orchestrate an elegant economic soft landing. Caution remains the word du jour.

It is going to take time for real estate prices to adjust, especially in the way many of us believe they will.  It is simple math. If your cost of carry doubles this quickly, prices and cap rates must adjust despite a limited supply. Next week holds a lot of critical news for CPI, PPI, retail sales, and bank earnings. Buckle up as it is going to be a rough ride as we anticipate these updates. We hope things will not be as painful as the Fed wants us to believe.

Market Commentary 9/30/2022

Posted on by Damon Germanides

Mortgage Rates Ease As Economy Shows Signs of Slowdown

Market pain remains the theme. There are simply too many variables to consider for anyone to know what is going to happen in the economy. The UK shocked markets this week when conflicting policy decisions by different parts of the government caused bonds to soar. In addition, the Pound plunged and pension funds cried for help as their treasury positions got smoked. Losses from the UK pensions were magnified due to leverage. Back here in the US, still the best place to invest by far, markets remain rocky. The bond market is back in charge of the direction of equities, real estate, and all other asset classes. Want to see where the world is headed? Continue to watch the 10-year Treasury for a sign. Should it move above 4.000%, there is the expectation pain for the markets will be even more exacerbated. Hopefully, it can find some footing under 3.500%- 3.750%. This would help bring the fear premium out of mortgage and other debt markets. While financing costs remain high, it does not benefit the economy for activity to crawl to a halt. As historical events like the Great Financial Crisis of 2008 and Covid 2020 have shown, it is hard to restart the economic machine once it’s stopped.

Has Inflation Reached Its Peak?    

The Fed’s favorite inflation gauge, the PCE, came in hotter than expected yet again.  However, markets shrugged off this bad news as bonds and equities early on in the trading session, but markets fell apart in the afternoon. This may be a sign that we have reached peak inflation as this report did not cause the market to panic. Our internal conversations with clients support the notion that the economy is slowing. Business owners are starting to hunker down, retail sales of luxury items are slowing (a sign that even the rich are beginning to worry),  restaurants seem much less busy and the residential and commercial real estate markets are materially slower. 

With negativity at 2008 levels across financial markets, perhaps we are nearing the end of the damage to the economy and markets. It is hard to tell, but valuations have certainly come in. A reasonable bottom in the S&P may be approaching (3,200 – 3,400). The Fed will continue to tighten, but, the pace with which they have gone so far may justify a pause or slow down to .25 -.50 bp increases over the coming year-end meetings. This column previously advocated rate hikes and was not excited about ongoing stimulus or other money giveaways, all of which are of course inflationary.  However, the Fed message is clear now, and doing too much too quickly to combat inflation may unnecessarily damage the fragile global financial system.  We think the Fed, like us, is seeing the economy weaken and confidence deteriorate to the point that inflation will subside.    

Market Commentary 9/23/2022

Posted on by Damon Germanides

Markets In Turmoil As Fed Raises Rates Yet Again

It was another brutal week for the equity and bond markets. Fed Chairman Powell reiterated his belief that pain is necessary in order to bring down inflation. The Fed raised by 75 bp and emphasized that more hikes are ahead. Chances are very high of a global recession. Bank CEOs are talking about stagflation, or a combination of slow growth, high unemployment, and rising rates. The volatile gyrations in the equity market make us wonder when something will break. Fear is high as it feels as if we are paying back all of the stimulus and easy money policies we’ve had over the last few years… With interest. 

If you listened to the talking heads, you would think there is no loan activity.  While the rapid rise in rates has slowed the pace of activity, there are still transactions happening at the right price. With the rise in interest rates, it is harder to qualify for a mortgage. This will continue to put pressure on housing prices.

Famed bond investor Jeffrey Gundlach spoke after the Fed’s meeting this Wednesday and made some good points.  He sees the S&P bottoming somewhere between 3,500 and 3,000. He is also noticing some very compelling bond opportunities. In particular, he advised that you should never time the bottom. As the market washes out, you should not sell, but look to accumulate for the long term. This same formula applies to real estate investing. Become more opportunistic while there is panic in the air. 

Market Commentary 9/16/2022

Posted on by Damon Germanides

All Eyes On Fed Next Week As Markets Remain On Edge

FedEx, one of the premier delivery companies worldwide, warned of a global recession. This is concerning news, given their intimate knowledge of the manner goods and services flow through the global economy. This warning came on the heels of ongoing fears amongst market participants about inflation, Fed tightening, and stagflation anxiety (stagflation is the combination of rising costs, higher unemployment, and slowing growth). One can look at the equity markets as a proxy for deflating asset prices worldwide. Fed Chair Powell echoed this much when he used the word “pain” on two separate occasions when discussing the Fed’s plans to bring inflation down, which is through the combination of higher rates and wealth destruction. One should remember the words “don’t fight the Fed” applies to both uptrends and downtrends.

How Deep Will The Recession Go?

A .75 bp hike on the short-term Fed Funds Rate is baked in at near 100%. However, there is a chance the Fed may go up to 100 bp in hikes. Given the slowdown in housing, the destruction of wealth in many Americans’ retirements, equity/bond holdings, and the grim outlook by business owners, our hope is that a 100 bp hike does not become a reality. Slow and steady may be a better policy. We have advocated for more and faster hikes in previous commentaries, but, the combination of Fed hikes and quantitative tightening (which is just rolling out) may succeed in bringing down inflation.  The aim at this point is to avoid a deep global recession. The comments from FedEx should not go ignored. Next week’s Fed meeting is so important, as a too-aggressive Fed could break something, which would not be good. Breaking inflation by way of an international financial crisis serves no one’s interests and would do more harm than good.  

The Lending Narrative Continues

On the lending side, higher short-term rates and even higher longer rates impede the ability of new buyers to qualify for mortgages. Home builders are trading poorly as are home improvement companies. Housing is a major component of GDP growth so there is no doubt in our minds that the U.S. is in a mild recession.  The bigger question is, how long does this last? When do interest rates top out, how will new and existing home sales and all other property types adjust to much higher interest rates? While there are lenders making practical decisions on applicants, increased mortgage payments have doubled from where they were just a few months ago. This will be a drag on housing prices, even with the limited demand in many large cities. A bit of positive news though, as potential new buyer income is holding up, and many are looking to the current volatile market as a good entry point.   

The great Warren Buffet is famous for saying he is greedy when others are fearful. Well, there is certainly fear in the air. Smart and thoughtful purchases of assets such as real estate or high-quality equities may be at the beginning phase of attractiveness.